What To Do When Your Small Business Gets Audited

For small business owners, the prospect of an audit can be shocking and scary. They come to us with all sorts of questions: how far back can the IRS audit a small business? How long does an IRS audit take? What is their personal liability in all of this? While there is no substitute for meeting with an actual qualified tax attorney, our team put together this page of basic information to help you understand the nature of a small business audit.

Why Do Businesses Get Audited?

Our clients often wonder whether or not there’s any truth to the idea that there are certain small business IRS audit triggers. Do you know what percentage of small businesses get audited? Believe it or not, only about 2.5% of small business owners will be audited — so it can feel like there’s a bullseye on your back if you’ve been selected.

It’s important to understand that there are certain flags, or triggers, that can make you a more likely candidate for being audited. For example:

You consistently report year-over-year losses. If your small business (and especially your sole proprietorship) appears to be constantly losing money, the IRS will begin to get suspicious about whether you’re intermingling your business and personal funds.

You’re bad about filing on time.If it looks like you’re not taking your obligations to the IRS seriously, you’ll be raising the alarm on their end. Filing late every year doesn’t just look bad, it’s indicative of someone who is not paying attention to the rules.

Endless deductions.Deductions need to be “ordinary and necessary” for your line of work, so if you’re claiming every little lunch and vehicle expense, you may be in for a nasty surprise from the IRS.

You run a cash-based business.When the majority of your transactions are cash-based and therefore reliant on accurate accounting, you open yourself up for greater scrutiny due to the temptation to under-report. If you operate a cash-based business, you need to be extra diligent about accuracy and honesty.

Not reporting offshore holdings or income.You need to pay taxes even on earnings and assets located in other countries. Failure to do so is a big problem that the IRS will punish to the fullest extent they can.

Making cryptocurrency a large part of your business.Cryptocurrencies like Bitcoin are new and exciting, but they also have some nefarious financial applications that the IRS is looking out for. If you make Bitcoin a part of your operations, expect to increase your chances of an audit occurring.

You are structured as a sole proprietorship.For small businesses, perhaps the single greatest increase to your audit risk is to be structured as a sole proprietorship. That’s because with this structure, the line between what’s a business dollar and what’s a personal dollar can get extremely murky. The IRS expects you to maintain a spotless accounting of which is which, and failure to do so can come with serious consequences during an audit.

What Is The IRS Audit Process?

Let’s start by first understanding what an IRS audit is, in its most basic terms. When you’re audited for a given business year, the IRS will compare your tax return to your actual books to see if there are any discrepancies. But that’s not all: they’ll also dig through bank statements, receipts, transaction histories, invoices, and more. Yes, being audited by the IRS and having no receipts is not a valid or effective defense or excuse for your sloppy bookkeeping. The IRS is powerful and meticulous during an audit, leading to the frightening reputation associated with this process.

It goes without saying that, should the auditor uncover discrepancies, you’ll be on the hook for unpaid taxes, penalties and interest. Of course, there are avenues through which you can dispute these findings, but you’ll likely want to enlist the help of an experienced tax attorney before taking on the IRS.

Note that most small business IRS audits occur within a 2 to 6 year window of the tax return in question. That’s not a hard and fast rule, but it does generally sum up the time period with which small business audits occur.

Small Business Audit Requirements

If you’ve received notice through the mail that your small business is going to be audited by the IRS, there are some things that you should and must do to prepare.

First, you should strongly consider enlisting the help of a tax attorney during this process, particularly if you know that you have been bad about filing on time and accurately. You should also become extremely familiar with the tax return that’s being audited, down to the last detail. Go through all your records and find every little scrap of evidence you can to substantiate the numbers reported on that tax return.

You should also present your evidence in as professional and orderly a fashion as possible. Remember, your auditor is a human: when you throw piles and piles of unorganized documents at them, that’s essentially adding fuel to the fire that there will be discrepancies, and they may take that as carte blanche to dig even harder. On the other hand, if your records are professionally prepared and neatly presented, you stand a better chance of limiting the scope of their investigation.

You’ll want to catalog and prepare a variety of commonly relevant and requested documentation for your audit. That often includes:

Bank statements and receipts. This is a big one, as it shows the inflow and outflow of your transactional history. Keep in mind that you’ll need to provide both your personal statements as well as that of your business.

Electronic records.We’ve come a long way from the days of pen and paper being the only valid form of documentation. Your credit card histories and associated online records will be of serious interest to the IRS, so make sure you have them ready.

Vehicle records.The IRS can be sticklers for claims or deductions made in regards to your vehicle(s). One reason for this is because many people cheat on their taxes by over-reporting the extent to which a vehicle was necessary for their business, and seek to use the wear and tear on their car(s) to defray their tax obligation. As such, be ready to provide an exhaustive reporting of your vehicle’s maintenance history, a log of when it was used for which business purpose, and corroborating calendar items for each of these.

If you’re faced with the intimidating prospect of having your small business audited by the IRS, you don’t have any time to waste. Contacting a veteran tax attorney at Abajian Law can make all the difference in terms of emerging from your audit experience unscathed and with your finances intact.

Experienced IRS Tax Attorney

Vic was a Senior Trial Attorney with the IRS Office of Chief Counsel in Laguna where he was recognized by the Department of Treasury for his exemplary service. As a Senior IRS Tax Lawyer, Vic has successfully represented clients on all types of tax issues.